TOPIC 5:

ACCOUNTING FOR EARNINGS PER SHARE (IAS 33)

Definition: EPS refers to the potential earnings attributable to each share held by the ordinary
shareholders of the company assuming that all the net profit after tax after payment of preference
dividends is distributed to them.
The net profit after tax is determined using the structure below:
Sales X
Less: COGS (X)
Operating profit X
Less: Operating expenses (X)
PBIT X
Less: Interest (Finance costs) (X)
PBT X
Less: Tax (X)
PAT (Attributable to shareholders) X
Less: Preferred dividends (X)
Earnings attributable to OSHs X
Less: Ordinary dividends (X)
Retained profits for the year X
There are two approaches to determining the EPS namely:
Basic EPS: Basic earnings per share is calculated by dividing the profit or loss on continuing
operations attributable to ordinary shareholders by the weighted average number of ordinary
shares in issue during the period.
𝑁𝑒𝑡 𝑝𝑟𝑜𝑓𝑖𝑡(𝑙𝑜𝑠𝑠)𝑎𝑡𝑡𝑟𝑖𝑏𝑢𝑡𝑎𝑏𝑙𝑒 𝑡𝑜 𝑜𝑟𝑑𝑖𝑛𝑎𝑟𝑦 𝑠ℎ𝑎𝑟𝑒ℎ𝑜𝑙𝑑𝑒𝑟𝑠 𝑖𝑛 𝑡ℎ𝑒 𝑦𝑒𝑎𝑟
𝐸𝑃𝑆 =
𝑊𝑒𝑖𝑔ℎ𝑡𝑒𝑑 𝑎𝑣𝑒𝑟𝑎𝑔𝑒 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑜𝑟𝑑𝑖𝑛𝑎𝑟𝑦 𝑠ℎ𝑎𝑟𝑒𝑠 𝑖𝑛 𝑖𝑠𝑠𝑢𝑒 𝑑𝑢𝑟𝑖𝑛𝑔 𝑡ℎ𝑒 𝑦𝑒𝑎𝑟
IAS 33 gives guidance on how to determine:
✓ The earnings figure that must be used being the net profit (or loss) attributable to ordinary
shareholders during a period
✓ The number of shares to be used in the calculation being the weighted average number of
shares in issue during the period.
ARISING ISSUES IN COMPUTING THE EARNINGS FIGURE

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 1. Continuing Vs. Discontinued operations: The total earnings figure is the profit or loss
from continuing operations attributed to ordinary shareholders after deducting tax and
preference dividends. In case of discontinued operations, the corresponding EPS is
separately computed and disclosed in the notes. In the case of consolidated financial
statements, this is determined after excluding the earnings attributable to non-controlling
interests but after including the share of profits or losses from associates.
2. Redeemable Vs. Irredeemable Preference shares: Preference shares are either classified
as equity or liability (IAS 32: Financial Instruments: Presentation). Irredeemable
Preference shares are classified as equity and any dividend relating to these shares must be
deducted from the profit or loss from continuing operations in determining earnings
attributable to OS. If preference shares are however redeemable, they are classified as
liability and any dividend relating to these share are recognized as part of finance cost
(together with interest expense).
3. Cumulative Vs. Non-cumulative preference shares: Where preference shares are
cumulative, the dividends relating to these shares must be deducted from profit or loss from
continuing operations regardless of whether the dividend has been declared or not.
Dividends on non-cumulative preference shares are only deducted if they are declared.
EXAMPLE
In the year ended 31 December Year 2022, G Ltd made profit after tax from continuing operations
of Sh. 3,500,000. G has Sh. 1,000,000 10% cumulative preference share capital in issue. G Ltd
had 1 million ordinary shares in issue throughout the year. No preferred dividend was paid during
the year 2022.
Basic EPS = [3500000 – 100,000]/1000000 = 3.4/share
4. Participating Vs. Non-participating Preference shares: Where preference shares are
participating, they have the right to share in the dividends together with the ordinary
shareholders according to a predetermined formula. In such cases, Profit or loss for the
period is allocated to the participating preference shares in accordance with their dividend
participation rights. Non-participating preference shares have no such rights.
EXAMPLE
X Limited has non-convertible preference shares in issue. These have the right to participate in
any extra earnings after ordinary shares have been paid in a ratio of 20:80. The ordinary shares
earn an initial dividend of Sh. 2.10 per share.
The following information relates to the financial year just ended.
Profit attributable to equity shareholders Sh. 100,000
Number of ordinary shares 10,000
Number of non-convertible preference shares 6,000
Non-cumulative annual dividend on preference shares
(before any dividend is paid on ordinary shares) Sh. 5.50 per share
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 Compute the basic EPS
Solution
The earnings attributable to ordinary shareholders is as follows:
Profit attributable to equity holders 100,000
Less dividends paid:
Preference (6,000 shares x Rs. 5.50 per share) (33,000)
Ordinary (10,000 shares x Rs. 2.1 per share) (21,000)
Undistributed earnings (to be shared) 46,000

Allocation of the undistributed earnings:

Let C be the allocation of undistributed earnings per ordinary share.
Let P be the allocation per preference share.
Therefore: 10000C +6000P = 46,000
But we know that P = 0.25C, Hence, 10000C + 6000*0.25C = 46,000
C = 4 and P = 1
Dividends distributed to Ordinary shares = 4*10000 = 40000 and
Dividends distributed to Preference shares = 1*6000 = 6000
Basic EPS to ordinary shareholders = 2.1+4.0 = 6.1/share
COMPUTING THE WEIGHTED AVERAGE NUMBER OF SHARES
In computing the weighted average number of shares to be applied in determination of EPS, the
ideal situation is that the number of shares in issue remains the same from the beginning to the end
of the year. However, this may not always happen as the entity may see the need to vary this
number at any point of the year.
1. Changes in the number of shares during the year that are fully paid: Where the firm issues
additional shares during the year that are fully paid for, the weighted average number of shares
should be computed considering the duration that such shares have been on issue. This is because
issued shares contributes additional capital to the firm that boosts the earning capacity of the firm.
That aspect must therefore be included in the computation of the basic EPS.
Example:
Company A has a financial year ending 31 December. On 1 January 2022 there were 6,000,000
ordinary shares in issue. On 1 April 2022, it issued 1,000,000 new shares at full market price. Total
earnings in Year 2022 were Sh. 27,000,000. Calculate the basic EPS

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 6,000,000 * 12/12 (were available for the whole year) = 6,000,000
1,000,000 *9/12 (were available for ¾ of the year) = 750,000
Weighted average no. of shares = 6,750,000
Basic EPS = 27,000,000/6750000 = 4/share
Alternatively:
6,000,000 * 3/12 (were available for the ¼ year) = 1,500,000
7,000,000 *9/12 (were available for ¾ of the year) = 5,250,000
Weighted average no. of shares = 6,750,000
EPS = 27,000,000/6750000 = 4/share
2. Partly paid shares issued within the year: Where the firm issues additional shares during the
year that are only partly paid for, the weighted average number of shares should be computed
considering the duration that such shares have been on issue and also considering the proportion
to which they have been paid for. This is because issued shares contributes additional capital to
the firm only to the extent that they have been paid for; which defines their rights to participate in
dividends. That aspect must therefore be included in the computation of the basic EPS.
EXAMPLE
Company A has a financial year ending 31 December. On 1 January Year 2022 there were 6 million
ordinary shares in issue. An additional 1 million shares were issued on 1st April Year 2022. These
shares were partly paid to 25% of their full value. Total earnings in Year were Sh. 27 million.
Compute the Basic EPS:
6,000,000 * 12/12 (were available for the whole year) = 6,000,000
1,000,000 *9/12 @ 25% (were available for ¾ of the year) = 187,500
Weighted average no. of shares = 6,187,500
EPS = 27,000,000/6187500 = 4.36/share
3. REPURCHASE OF SHARES: Sometimes, the firm may reduce it’s shareholding by
repurchasing the shares in the open market. That must be considered in computing the weighted
average number of shares in the light of the duration over which the shares were on issue.
Example
Eddie Ltd, whose year-end is 31 December, has earnings attributable to equity shareholders of
$4m in 2022. The number of equity shares outstanding on 1 January 2022 was 30 million. On 1
May 2022 Eddie issued a further 15 million equity shares at full value. On 1 November 2022 Eddie
repurchased 3 million equity shares at full market value.
Required: Calculate 2022 basic EPS for Eddie Ltd based on the above information.
Solution:
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 Date No. of shares Time weighting Effective shares
1 Jan – 30th April 30,000,000 4/12 4/12*30m = 10m
1st May – 30th Oct 45,000,000 6/12 6/12*45m = 22.5m
1st Nov – 31st Dec 42,000,000 2/12 2/12*42m = 7m
Total 39.5 million

Basic EPS = 4,000,000/39.5 MILLION Shares = $0.1/share

4. BONUS ISSUES OF SHARES/SHARE SPLIT TRANSACTION (TREATED THE SAME):

A bonus issue of shares (also called a scrip issue or a capitalization issue) is an issue of new shares
to existing shareholders, in proportion to their existing shareholding, for free. No new cash is raised
from a bonus issue; therefore the firm does not realize any boost in earnings. The new number of
shares after the bonus issue can be found by multiplying the number of shares before the bonus
issue by the bonus issue fraction; where:
Bonus issue fraction = Shareholding after bonus/Shareholding before bonus
IAS 33 specifies that the bonus shares issued are not time apportioned and are assumed to be
available throughout the years for purposes of computing EPS.
This implies that the EPS for the previous years must be restated to reflect the bonus issue and to
enhance comparison of EPS.
EXAMPLE
Company C has a 31 December financial year end. On 1 January 2022 it has 4 million shares in
issue. On 1 July 2023 it made a 1 for 4 bonus issue. The financial results for Company C in both
years were as follows.
Year 2023 Year 2022
Total earnings Rs. 20,000,000 Rs. 20,000,000
There were no share issues in Year 2022.
Basic EPS in Year 2022 was: Rs. 20,000,000/4,000,000 shares = Rs. 5 per share.
Basic EPS in Year 2023 was: Rs. 20,000,000/5,000,000 shares = Rs. 4 per share.
For comparison purposes, the shares of year 2022 should be adjusted for the bonus issue effect in
year 2023 so that the shares used = 5,000,000 instead of 4 million (IAS 33)
Example 2

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 Frank Ltd, whose financial year-end is 31 December had 2022 earnings of €100,000. The number
of equity shares in issue on 1 Jan 2022 was 500,000. A bonus issue took place on 31 May 2022
the terms of which were that three new shares were issued free for every 5 already held. The
reported EPS for 2021 was 0.15/share.
Required: Calculate the 2022 basic EPS for Frank Ltd based on the above information. Calculate
also the comparative figure for 2021 to be disclosed in the 2022 annual report.

Solution
Date No. of shares Time weighting Bonus fraction Effective shares
1 Jan – 31st May 500,000 5/12 8/5 500*5/12*8/5 =
333,333
1st June – 31st Dec 800,000 7/12 7/12*800 =
466,667
Total 800,000

Or
500,000 * 800,000/500,000 = 800,000 SHARES
Basic EPS = €100,000 / 800,000 = €0.125 per share.
The 2017 EPS figure is adjusted by the inverse of the bonus fraction:
Restated 2017 EPS: 0.15c *5/8 = 0.09375 per share
5. RIGHTS ISSUES OF SHARES
A rights issue of shares is an issue of new shares for cash, where the new shares are offered initially
to current shareholders in proportion to their existing shareholdings usually at below the current
market value.
Unlike the bonus issue, rights issue shares are time-apportioned.
However, in every rights issue, there is a bonus and the fair value components each of which must
be determined and considered in the calculation of the weighted average number of shares.

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The bonus component represents the free component of the rights issue which is the difference
between the theoretical ex-rights price and the rights exercise price. The theoretical ex-rights price
is the average value of one share assuming all the rights are exercised.
Bonus(free) component = Theoretical Ex-rights price – Exercise price
The fair value component represents the value that the shareholder pays to acquire additional
shares and is the difference between the exercise price and the bonus value in a rights issue.
Fair value component = Exercise price – Bonus component
Example:
ABC PLC which has a year-end of 31st December 2022, issued 1 for 3 rights shares on 30th June
2022. The exercise price for shares was $1.5 whereas the market price of ABC PLC shares just
prior to the issue of rights shares was $2. All rights were exercised on 30th June 2022. Following
information relates to ABC PLC:
Ordinary Shares as on 1st January 2021: 3,000,000
Earnings attributable to ordinary shareholders:
2021 $6,400,000
2022 $7,200,000
Calculate the Basic Earnings per Share for 2021 and 2022
Step 1: Calculate the new rights shares: = 3,000,000/3*1 = 1,000,000
Step 2: Calculate the Theoretical Ex-Rights Price (the theoretical average value per share after
the rights issue). NB: The market price is not a reliable price for the share, so we use the
theoretical ex-right price.
Market value of 3 held shares @ 2 6
+Value of 1 right share @ 1.5 1.5
Total value for 4 shares 7.5
Average price per share = 7.5/4 1.875 (Theoretical Ex-right price)
Step 3: Calculate the bonus and Fair Value components of the rights shares issues
Bonus (free) component = 1.875-1.5 = 0.375 This is equivalent to (0.375/1.875) % = 20%
That implies that the fair value component =100% -20% = 80%
Converting these percentages into shares:
Bonus shares = 20%*1,000,000 = 200,000 shares
Fair value component shares = 1,000,000-200,000 = 800,000 shares
Step 4: Calculate the weighted average no. of shares

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2021 = outstanding shares + Bonus shares = 3,000,000 + 200,000 = 3,200,000
2022 = outstanding shares + Bonus shares + Fair value shares
= 3200000+[800000*6/12] = 3.6 million
EPS: 2021 = 6,400,000/3,200,000 = $2/share
EPS 2022 = 7,200,000/3,600,000 = $2/share

Example 2
Number of shares in issue on 1 Jan 2022 750,000
Earnings for the year to 31 December 2022 €50,000
EPS for 2021 0.09 per share
Rights issue on 1st April 2022, 25% at a price of €1.00.
Market price of shares on 31 March 2022 €1.25
Required: Calculate basic EPS for 2022 and restate the comparative for 2021.
Solution:
Step 1: New rights issued shares = 750,000*25% = 187,500 shares
Step 2: Theoretical ex-rights price = (The rights issue is equivalent to 1 for 4 shares) =
750,000/187,500 = 4
For every 4 shares that was in issue, valued at €1.25 each, total value is €5.00
There was issued 1 further share, at a price of €1.00, adding value of €1.00
There are now a total of 5 shares, with a total value of: €6.00
Hence, average value per share should be (€6.00 / 5 shares) €1.20
Bonus & Fair value components:
Bonus (free) = 1.20 – 1.00 = 0.2/1.20*187,500 = 31,250 shares
Fair value = 187,500 – 156,250 shares (shares paid for)
Step 4: Calculate the weighted average no. of shares
2021 = outstanding shares + Bonus shares = 750,000 + 31,250 = 781,250
2022 = outstanding shares + Bonus shares + Fair value shares
= 781,250+[156,250*9/12] = 898,437.5
EPS: 2021 = Finding Income attributable to ordinary shareholders = 0.09 * 750,000 = $67,500

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Adjusted EPS = $67,500/781,250 = $0.086/Share
EPS 2022 = 50,000/898,437.5 = $0.06/share

DILUTED EPS
‘Dilution’ means ‘watering down’ or ‘reducing in strength’. This occurs when an entity has other
instruments of capital which may potentially be converted into ordinary shares at some date in the
future. These could include: convertible bonds, convertible preference shares, share options, share
warrants etc. If these potential shares become actual ordinary shares, the earnings figure will be
shared with a larger number of ordinary shares; hence diluting the EPS.
It should however be noted that additional shares issued at full price are not considered dilutive
because there is a corresponding increase in capital to boost the earnings capacity. Therefore, only
additional shares corresponding with no increase in capital (free shares) are considered dilutive.
IAS 33 requires publicly-traded companies to calculate a diluted EPS in addition to their basic EPS
for the current year (with a comparative diluted EPS for the previous year). The diluted EPS
essentially allows for the effects of all dilutive potential ordinary shares. Diluted EPS is calculated
by adjusting the earnings and number of shares figures used in the basic EPS calculation.
The Earnings are adjusted to remove the effect of dividends or interest that have been recognized
during the year for the potential ordinary shares, and for any other income or expense that would
alter as a result of the conversion of the potential ordinary shares into actual ordinary shares.
1) Convertible preference shares and convertible bonds
For convertible preference shares, total earnings are adjusted by adding back the preference
dividend paid or payable in the year. Total earnings will be increased by the preference dividend
saved.
For convertible bonds, the interest charge on the bonds in the year is added back less the tax relief
relating to that interest.
The total earnings will therefore increase by the interest saved less tax i.e. Interest*(1-T) where T
= Tax rate.
The weighted average number of shares is increased, by adding the maximum number of new
shares that would be created if all the potential ordinary shares were converted into actual ordinary
shares (i.e. use the most dilutive option when multiple conversion options are available).
Usually, the additional number of shares is calculated on the assumption that the convertible
securities were in issue from the beginning of the year.
However, if they were issued at any point during the year, the potential shares must be time-
weighted from the date of issue.
Example 1
G Ltd had the following capital structure as at 31 st December 2020:

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12 million ordinary shares @ Sh 1 12,000,000
200,000 8% convertible preference shares@ Sh 10 2,000,000
5% convertible bonds of Sh. 100 each 4,000,000
Total 18,000,000
i. The preference shares are convertible at 3 ordinary share for every 1 held
ii. The bonds are convertible into ordinary shares as at 31st December 2021 or 31st December
2022, at the following rates:
• At 30 shares for every Sh. 100 of bonds if converted at 31 December 2021,
• At 25 shares for every Sh. 100 of bonds if converted at 31 December 2022.
iii. Total earnings for the year ended 31 December 2020 were Sh. 36,000,000.
iv. Tax is payable at a rate of 30% on profits.
Calculate the basic EPS and diluted EPS for the year ended 31st December 2020.
Basic EPS: = Sh. 36,000,000/12 million = Sh. 3 per share

Diluted EPS:
Details Shares Earnings
Basic EPS 12,000,000 36,000,000
Preference shares: Conversion (200,000/1*3) 600,000
Add back: Preferred dividends (8%*2 million) 160,000

Max. Conversion: 4,000,000/100*30 1,200,000

Add back interest: 5%*4,000,000 200,000
Less: Interest saving: 30%*200,000 (60,000)
Net 13,800,000 36,300,000
Diluted EPS 36,300,000/13,800,000 = 2.63/Share
Note that: If new convertibles are issued during the course of the year, the adjustment in number
of shares, the earnings and tax saving is time-apportioned e.g. perform the above example
assuming the convertible Preference shares and bonds were issued on 1st April 2020.
Shares Earnings
Basic EPS 12,000,000 36,000,000

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Preference shares: Conversion (200,000/1*3)*9/12 450,000
Add back: Preferred dividends (8%*2 million) *9/12 120,000

Max. Conversion: (4,000,000/100*30) *9/12 900,000

Add back interest: 5%*4,000,000*9/12 150,000
Less: Interest saving: 30%*200,000*9/12 (45,000)
Net 13,350,000 36,225,000
Diluted EPS 36,225,000/13,350,000 = 2.71/Share

2) Options and Warrants

Options are contracts issued by a company which entitle the holder to buy a certain number of
shares of the company at some time in the future for a pre-agreed price.
The problem presented by share options is that although the amount receivable upon exercise of
the option is known, it is impossible to predict how total earnings will be affected when the cash
is eventually invested.
The dilemma therefore is that including the new shares in the diluted EPS calculation without
adjusting the earnings would be inconsistent.
IAS 33 solves this problem by regarding the amount that would be received on exercise of the
options as cash received from selling shares at full price with the excess shares treated as shares
issued for free.
The logic is that the shares sold at full price should not be considered as dilutive as any cash would
be invested to earn the same return as earned in the period.
It is only the free shares that are dilutive.
Example 2
J had total earnings of Sh. 25,000,000 for year ended 31st December 2021. It has 5,000,000
ordinary shares in issue during the year. There are outstanding share options on 400,000 shares,
which can be exercised at a future date, at an exercise price of Sh. 25 per share. The average market
price of shares in Company J during Year 2021 was Sh. 40. Calculate the diluted EPS for Year
ended 31st December 2021:
Step 1: Cash proceeds receivable from exercise of the options: 400,000 * 25 = 10,000,000
Step 2: Divide cash proceeds by the average share price in the period to obtain the no of shares
issuable at full price: 10,000,000/40 = 250,000 shares (these shares won’t be dilutive)
Step 3: Deduct the no. of shares obtained in step 2 from no. of shares issued on exercise of the
option to obtain the no. of free shares: 400,000 – 250,000 = 150,000 (dilutive shares)

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New shares = 5,000,000 + 150,000 = 5,150,000
Earnings (unchanged) = 25 million
Diluted EPS = 25 million/5,150,000 = 4.85/share (Basic EPS = 25 million/5 million shares =
5/=per share
Note: Options are only included in the diluted EPS calculation if the average share price in the
year is greater than the exercise price of the option (in the money).
Out of the money options are said to be antidilutive and hence excluded.
DILUTION TEST OF POTENTIAL ORDINARY SHARES
IAS 33 provides that only dilutive potential ordinary shares are included in the dilutive EPS
calculation. A potential ordinary share is said to be dilutive if its inclusion in the calculation of
diluted EPS reduces the EPS even further. Potential ordinary shares whose inclusion increases the
diluted EPS are said to be antidilutive and must not be included.
When there are several types of potential ordinary share in issue, they should be ranked in order
of dilution, with the most dilutive potential ordinary shares ranked first.
This is done by ranking the earnings per incremental share for each potential ordinary share.
A diluted EPS should then be calculated in stages, taking in one potential ordinary share at a time,
to establish whether any of them are not dilutive.
Note: In the money options always rank first as they increase the number of shares in the
calculation without affecting the earnings (they have shares effect without having earnings effect)
Example:
The following information relates to Company L for the year ended 31 December Year 2015.
Number of ordinary shares in issue 5,000,000
Reported earnings in the year Sh. 15,000,000
Basic EPS 3.00/Share
Average market price of shares during the year Sh. 80
Potential ordinary shares:
1. 600,000 options, with an exercise price of Sh. 60 (in the money)
2. 4% convertible bond: Sh. 5,000,000 convertible in Year 2020 into ordinary shares at the
rate of 40 new shares for every Sh. 100 of bonds
3. 100,000 7% convertible preference shares of Sh. 10 each. Preference share is convertible
in Year 2019 into ordinary shares at the rate of 1 ordinary share for every 20 preference shares
Tax rate = 30%
Compute the diluted EPS for the year to 31 December Year 2015:
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Testing the order of dilution
i. Options
Step 1: Cash proceeds from exercise of the options: 600,000 * 60 = 36,000,000
Step 2: Divide cash proceeds by the average share price in the period to obtain the no of shares
issued at full price: 36,000,000/80 = 450,000 shares
Step 3: Deduct the no. of shares obtained in step 2 from no. of shares issued on exercise of the
option to obtain the no. of free shares: 600,000 – 450,000 = 150,000 (dilutive shares)
Dilution effect = Earnings effect/Shares effect
Earnings effect per incremental share = 0/150,000 = 0.00/share (always 0 if in the money)
ii. Convertible Bonds:
Increase in Shares (shares effect): [5,000,000/100]*40 = 2,000,000 shares
Increase in Earnings (earnings effect): [4%*5,000,000] - 30%of [4%*5,000,000] = 140,000
Earnings per incremental share = 140,000/2,000,000 = 0.07/share
Convertible Preference shares:
Increase in Shares: [100,000/20] = 5,000 shares
Increase in Earnings: [7%*100,000*10] = 70,000
Earnings per incremental share = 70,000/5,000 = 14/share
Rank by most dilutive = Option, followed by convertible bonds and then convertible Preference
shares
Computation of Diluted EPS in stages:
Details Earnings Shares EPS Comments
Reported 15 million 5 million 3.00 Basic
Options 15 million 5,150,000 2.91 Dilutive
Convertible Bonds 15.140 Million 7,150,000 2.12 Dilutive
Convertible P.S 15.210 Million 7,155,000 2.13 Antidilutive
The reported diluted EPS should be Sh. 2.12 (and not Sh. 2.13) since 2.13 is higher i.e. counter-
productive.

Contingently issuable shares

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A company might enter into a contract where it will issue shares on the occurrence of some future
event. Such shares have no effect on the basic EPS calculation until the condition actually
materializes.
They are considered in the diluted EPS only if the conditions leading to their issue have been
satisfied.
Contingently issuable shares are included in the diluted EPS calculation from the beginning of the
period or the date of the contingently issuable share agreement – whichever is later.
Example
Company M had 12,000,000 ordinary shares in issue as at 31 December 2020. Company M had
acquired a new business during the year 2019. As part of the purchase agreement Company M
would issue a further 1,000,000 shares to the vendor on 30 June 2021 if the share price reached Sh
500 at 31st Dec 2020. The share price was Sh 600 on 31 December 2020. Earnings for the year to
31 December 2020 were Sh. 100,000,000.
Basic EPS:
31 December 2020: Sh. 100,000,000/12,000,000 = Sh. 8.33 per share
Diluted EPS: Rs. 100,000,000/13,000,000 = Rs. 7.69 per share
Contingently issuable shares have nil earnings effect and hence are always dilutive.
Note: Shares that are issuable after a period of time are not contingently issuable shares because
passage of time is a certainty. They must therefore be included in the calculation of diluted EPS
Limitations of earnings per share
EPS is probably the single most important indicator of an entity’s performance. It is a very useful
measure when it is used as the starting point for a more detailed analysis of an entity’s performance.
However, EPS can have serious limitations:
a) Not all entities use the same accounting policies. It may not always be possible to make
meaningful comparisons between the EPS of different entities.
b) EPS does not take account of inflation, so that growth in EPS over time might be
misleading.
c) EPS measures an entity’s profitability, but this is only part of an entity’s overall
performance. An entity’s cash flow can be just as important as its profit (and more essential
to its immediate survival). Changes in the value of assets (holding gains) can also be an
important part of performance for some entities.
d) Diluted EPS is often described as an ‘early warning’ to investors that the return on their
investment may fall sometime in the future. However, diluted EPS is based on current
earnings, not forecast earnings. This means that it may not be a reliable predictor of
future EPS.

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